Adaptive Portfolio Strategy

Posted on June 05, 2017

Market Update 6/05/2017

Macro - Market State (Based on the S&P 500)Market State 1: Bullish/Rational (8 trading days): Market State 1 - Money is only made when a market, or portfolio, establishes a new high. For example, a 15% gain means very little if it were preceded by a -20% loss.

Almost all new highs occur in Market State 1. That said, the normal Market State 1 market correction is typically in the -3% to -5% ranges, measured from the highest peak in value. Such corrections can occur at any time and would be considered “random market noise.”

Canterbury Volatility Index (CVI 38): Volatility spiked on May 17 when the S&P 500 and Dow Jones declined almost 2% in one day. May 17th would be a “one day outlier” that is expected, and was predicted. Outliers tend to occur when volatility hits an extremely low level. Volatility, as measured by the CVI was at its lowest point in over 20 years on May 16th (the day before the decline) at CVI 32.

Volatility below CVI 35 is extremely low and is subject to random one day outliers in the 1.5% plus range (up or down). It would be common for the days following the outlier, to behave normally as if nothing out of the ordinary had happened.

Comment:
The S&P 500 has registered four new all-time highs over the last six trading days. Most profits come over relatively short periods of time. In other words, profits are not made consistently based on the calendar. It is not practical to put emphasis on short or intermediate periods of time.

Traded financial markets fluctuate and will have down periods between new peaks in value. We would like to see these periods, between the new highs be as short as possible.

The following chart of the S&P 500 gives a good illustration of the inconsistent nature of market returns due to “dead periods” in the market.
Source: AIQ

Risk management is the key to avoiding extended periods of being underwater in your portfolio. All traded securities will have positive or bullish market behavior as well as volatile periods during difficult market environments. Therefore, limiting the maximum declines, from your portfolio’s peak value (called drawdowns), is very important. The logical reason to limit drawdowns is because it should take less time to get back to reach a new high following a normal 5% pullback from the peak than it would if one were to suffer a 20% drop in value.

The Canterbury Portfolio Thermostat is an Adaptive Portfolio Strategy:
Adaptive portfolio strategy is designed to adjust the portfolio’s holdings to adapt to the existing market environment – bullish or bearish. The focus is on maintaining the most “efficient portfolio” possible that can benefit from the realities of the current environment.

The practice of assigning a fixed percentage asset allocation based on a subjective view of risk tolerance is flawed in several ways

Risk tolerance questionnaires cannot duplicate the emotional changes experienced by the individual investor through various events.

Even if risk tolerance could be defined, the traditional fixed allocation practice can’t adjust to changing markets. Thus, the investor’s risk tolerance might not be maintained anyway.

A “set it and forget it” approach will not provide meaningful value add to the long-term investment process. An occasional rebalance, back to the original allocation, might only have little impact on the outcome and there is no answer for the inevitable bear markets.

Adaptive Portfolio Strategy is designed to harness the advantage of significant breakthroughs in technology and innovative product development such as diverse Exchange Traded Funds (ETFs).

More About Tom Hardin

As Chief Investment Officer, Tom has more than 30 years of experience in the investment management industry and has a broad breadth of knowledge. He is known as an innovator, educator and has been revolutionary in the advancements of portfolio and risk management.

Every effort was used to provide accurate data and mathematical calculations to provide, what we believe to be, accurate results. Canterbury Investment Management, LLC, and its principal owners, make no guarantee of completeness or accuracy of data or calculations as well as conclusions of any statistical data or information contained in the simulation illustrated on this page. Past results or performance is in no way a guarantee of future results.